An attorney-pilot was denied the majority of claimed deductions relating to his use of an airplane in his law practice, as most of his flights were to locations within 100 miles of his home, and only a small number involved travel to court appearances, witness interviews, or other activities directly related to his practice. Peterson v. Comm'r, T.C. Memo. 2015-1.

Background

Tulane M. Peterson is an avid aviator and general practice attorney specializing in personal injury cases. In June 2005, he purchased a Cessna Turbo Skylane airplane for $332,000, ostensibly for transportation needs related to his law practice. Peterson kept a flight log, recording flight activities and categorizing the flights as either "training", "maintenance", or "business." Many of these flights were to airports within 100 miles of his home, but he maintained that flying made business sense because it enabled him to avoid Los Angeles traffic.

Peterson claimed that 100 percent of his flights, including those he had categorized as training and maintenance, entailed business expenses of his law practice. A relatively small percentage of these flights involved travel to court appearances, witness interviews, or depositions in litigation in which he was actually engaged. The remainder of his flights involved travel for personal or family reasons.

On his 2006 Schedule C, Peterson reported depreciation and Code Sec. 179 expenses relating to his airplane of $74,368, and other airplane-related expenses of $41,252. On audit, the examining agent determined that Peterson had substantiated $14,277 of airplane-related expenses; however, at the conclusion of the audit, the agent disallowed the entirety of the depreciation expense, the Code Sec. 179 election, and the remaining airplane-related expenses on the ground that none of those costs were ordinary and necessary for Peterson's trade or business.

Peterson reported similar expenses on his on his 2007 Schedule C. A different agent examined his 2007 return and determined he had substantiated all of the reported expenses. Relying on Peterson's flight logs, the agent determined that 27 percent of his flight hours were directly related to his law practice because they involved flights to court appearances, depositions, or litigation-related witness interviews and allowed a deduction for 27 percent of the airplane-related expenses. The agent also determined that Peterson was not eligible to make an election under section 179 because his airplane constituted "listed property" that was not predominantly used in his trade or business, but did allow a deduction equal to 27 percent of that amount.

The IRS sent Peterson separate notices of deficiency for 2006 and 2007 based on the reports of the examining agents. Peterson timely petitioned the Tax Court for redetermination of his tax liabilities.

Analysis

Taxpayers are allowed to deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business" (Code. Sec. 162(a)). An ordinary expense is one that is normal, usual, or customary in the taxpayer's industry (Deputy v. du Pont, 308 U.S. 488 (1940)). A necessary expense is one that is appropriate and helpful for the development of the taxpayer's business (Welch v. Helvering, 290 U.S. 111 (1933)). Strict substantiation is required for expenses relating to travel and "listed property," which includes airplanes (Code Sec. 274).

Taxpayers are also allowed to take depreciation deductions for certain tangible property used in the taxpayer's trade or business (Code Sec. 167). Where a taxpayer can demonstrate that the business use exceeds 50 percent, a taxpayer can elect to deduct the cost of certain property acquired and used in a trade or business and placed in service during the year (Code Sec. 179).

In examining the airplane expenses, the court questioned whether aeronautical expenses were ordinary and necessary given Peterson was a solo practitioner conducting business travel close to his home. The court noted a powerful argument could be made that none of the expenses should be regarded as "ordinary and necessary." The cost of owning and operating a private airplane did not appear to be "normal, usual, and customary" for an attorney in solo practice, especially one who made approximately 65 percent of his flights to destinations within 100 miles of his home. Nor, the court opined, would it seem "reasonable," at the cost of $236 to $433 per flight hour, to fly to destinations that could be reached by car in less than an hour.

However, by allowing Peterson to deduct 27 percent of his airplane-related costs for 2007, the IRS had conceded those costs were "ordinary and necessary" to the extent they were genuinely business related. The court stressed that the IRS is not required for any given year to allow a tax benefit that was permitted for a previous or subsequent year, but given the unique nature of the case, the court found it appropriate to treat Peterson's airplane-related expenses for 2006 and 2007 as "ordinary and necessary" to the extent they were business related.

The court then used the methodology for determining business use employed by the 2007 examining agent to determine that 18 percent of his 2006 flight hours were for business purposes, and allowed deductions for 18 percent of the substantiated business expenses. The court concluded that Peterson failed to establish a business purpose for the other airplane-related expenses and failed to substantiate certain 2006 expenses under the rigorous Code Sec. 274 requirements imposed for "listed property, denying the associated deductions. The court noted that receipts or invoices for maintenance of or repairs to the aircraft were conspicuously absent from Peterson's 2006 records.

In examining the airplane-related depreciation, the court found that Peterson was ineligible for the Code Sec. 179 deduction, as he failed to meet the "over 50 percent business use" requirement for both 2006 and 2007. However, as the IRS had conceded Peterson was allowed a depreciation deduction under Code Sec. 167 for 2007, the court allowed a "comparable" depreciation deduction for 2006 determined by reference to 18 percent deemed business use of the airplane.

For a discussion of trade and business expenses, see Parker Tax ¶90,100. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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